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5 Best Ways for Making Loans to Family and Friends

Money Girl explains what you show know about giving, lending, or borrowing when it involves family or friends, so you can protect both your finances and your long-term relationships.   

By
Laura Adams, MBA,
December 10, 2014
Episode #381

Page 1 of 3

5 Best Ways for Making Loans to Family and FriendsHave you ever wondered if you should make loans to family members or friends? Or maybe you’re the one who’s thinking about borrowing money from someone close to you?

In this episode, I’ll cover what you should know about giving, lending, or borrowing between family and friends. You’ll learn 5 of the best ways to make smart transactions that will help protect your finances and, more importantly, your long-term relationships.   .

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5 Best Ways for Making Loans to Family and Friends

While it may seem easy to borrow from or loan money to loved ones, it’s important to understand how it can affect both your financial lives. It's also crucial to note that how the borrower plans to use the money could play a role in how you handle the transaction. I’ll discuss more about that at the end of this article.

Here are the 5 best ways to exchange money between family and friends, and some key pros and cons that both parties should consider:

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Way #1: Make a Gift

If you can afford to make a cash gift to someone who needs help, instead of making a loan, that’s a wonderful solution. But remember that making the cash a gift means that you don’t intend for any amount of it to be repaid, ever.

Additionally, there are tax implications when you make a gift versus a loan. Many people don’t understand the federal gift tax, or even know that it exists. In a nutshell, any time you give something of value with no expectation of value to be received in return, it’s taxable—unless there’s a legal exception. For 2014 and 2015, you can give up to $14,000, to as many people as you like each year, without having to pay a gift tax. So let’s say you want to give $20,000 to someone this year - you’d have to pay gift tax on $6,000, which is the amount that exceeds $14,000.

The gift giver is generally responsible for paying tax, not the recipient. Here are some additional exceptions for when a gift is not taxable:

  • Gifts to a spouse who is a U.S. citizen 
  • Gifts to a political organization 
  • Medical expenses (including insurance premiums) that you pay for someone directly to the person or institution providing his or her services 
  • Tuition that you pay for someone directly to his or her school

So making a payment owed by someone else—for something other than tuition or medical expenses—is a gift to him or her, and may be subject to the gift tax. Also note that you cannot deduct the value of a gift from your income tax return—unless it qualifies as a tax-deductible charitable contribution.

See also: Which Charitable Contributions Are Tax Deductible?

There are also implications for your estate taxes that are linked to the gift tax, so if you’re not sure whether tax applies to your situation, read IRS Publication 559: Survivors, Executors, and Administrators. If you make a taxable gift, it must be filed using Form 709: U.S. Gift (and Generation-Skipping Transfer) Tax Return.

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